The State of Finance in the Legal Cannabis Industry

By Adam C. Uzialko, B2B Staff Writer June 9, 2017 07:10 am EST

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Credit: Open Range Stock/Shutterstock

The legal cannabis industry is one of the fastest growing in the U.S. In 2016 alone, the industry brought in $6.9 billion – a 30 percent increase over the previous year, according to Arcview Market Research.

Still, cannabis remains federally illegal, placing the entire legal industry in a precarious position subject to the whims of each Congress and administration. Banks and larger venture capital firms are hesitant to enter the game, leaving the industry undercapitalized.

The undercapitalization of a multibillion dollar industry

The federal prohibition has led to several problems, but few so stark as the lack of access to banking and conventional financing options like checking accounts, lines of credit and business loans. Its breakneck growth might appear healthy, but the cannabis industry has a financial albatross around its neck. Without the ability to bank like other businesses, entrepreneurs and employees alike suffer.

"There's no regular way to access institutional capital for the cannabis entrepreneur in the U.S.," said Hadley Ford, co-founder of iAnthus Capital Management. "Unless you have a rich family member or a strong balance sheet, you've got to bootstrap. And that [slows] the growth of the industry quite significantly."

"It's crippling right now. You don't realize how important banking is until you don't have it – just giving employees a paycheck is just brutal," added Keegan Peterson, CEO of payroll and HR company Wurk. "In a cash environment, it's difficult to even prove you paid [your employees], or your vendors, or your tax liability."

Banks aren't the only ones hesitant to enter the cannabis sector. Large venture capital firms have eyed the industry with interest, but thus far have been reluctant to stake much of a claim in the fledgling industry.

"With later stage companies, [it's] difficult to make the jump from raising a few million up to five or 10 million," Micah Tapman, managing director of Colorado-based accelerator CanopyBoulder, told Business News Daily. "There really aren't larger venture capital or private equity firms playing yet. They're looking at it but not writing checks."

A number of reasons beyond simply federal prohibition figure into their calculations, he said. The fragmented nature of the industry and the varying regulations state by state are also great concerns, in addition to the constant fear that the Department of Justice will reverse course on the Cole Memorandum, which has thus far allowed legal entities to operate in compliance with their home states' laws. All of this adds up to a significant lack of the working capital that would otherwise be in play.

As a result, the industry has produced some workarounds. Largely bootstrapped companies find themselves relying on angel investors and accelerators to get to the next level. Here are some of the solutions that have evolved out of the legal cannabis industry's financial plight.

The seed-stage cohort

Small cannabis companies are often bootstrapped or financed by friends and family. When those companies show promise, though, they are unable to seek a loan or a line of credit from a bank.

"Normally you get a startup business and a little money is coming in from somewhere, and then you start banking, [obtain a] line of credit from [a] bank, get a credit card and grow the business that way," Tapman said. "In cannabis, the banking stuff is off the table. Money comes from friends and family usually, and then you jump into the angel game with groups like the ArcView Network and their members."

Canopy offers programs in partnership with ArcView to prepare young cannabis companies for their capital raise. Canopy works exclusively with ancillary businesses, meaning products and services that don't directly touch the plant (i.e., no cultivators or dispensaries). Through a 16-week mentor program, Canopy provides a bit of capital and a lot of knowledge in return for a small stake in each company, which then raises additional funding from the associated angel network.

"We've seen a lot of success around companies doing that, and a lot of ours have raised north of $2 to $3 million," Tapman said.

Pulling in millions from north of the border

Some investment funds like iAnthus Capital Management have been founded explicitly to deal with the financing problem in the American cannabis industry. Ford and his partner, Randy Maslow, entered the Canadian public markets looking for investors and, in turn, directed the money toward viable operators in the U.S.

"In Canada you've got a market from an economic perspective where it's legal on the federal level medicinally and recreationally in next year or so," Ford said. "That has allowed financial markets to develop much more quickly than in the U.S. and, in particular, around the public market formulation of capital."

Ford and Maslow went to those markets twice to raise funds, bringing in about $41 million to invest into American cannabis operations. iAnthus Capital Management works exclusively with operators that touch the plant, like cultivators and dispensaries, injecting cash into an underserved sector of the industry.

For Ford, the cannabis industry will normalize soon, but in the meantime, it's in need of support.

"My firm belief is that within the next 10 years this will become an ordinary industry," he said. "It could happen faster. Two big pieces that would change the acceleration would be the descheduling of cannabis … [and] a tax anomaly called 280-E. If that goes away, it will give more confidence that the federal government is moving in the right direction and make banks and investors more comfortable."

Making payroll, paying taxes and tracking compliance

It can be difficult, if not impossible, to track the taxes your business owes and maintain a paper trail for payroll when operating in an all-cash environment. However, because most banks won't touch cannabis companies, that's exactly where entrepreneurs in the industry find themselves today.

Peterson's company, Wurk, seeks to ameliorate some of that pressure by handling compliance, calculating tax obligations and offering a paper trail for companies with cash-based payroll. This helps cannabis companies operating in a cash environment ensure they're doing everything to the letter of the law.

"Because cannabis is federally illegal, there's not many banks in the industry," Peterson said. "When you don't have banks, it's not easy to pay vendors, employees or taxes. [Entrepreneurs also] don't have access to lending from the bank. Business loans and lines of credit are not possible. It takes money to make money and these businesses are trying to grow, so they're finding alternate sources of money."

By generating tax forms and signed employee paychecks, Wurk helps cannabis entrepreneurs track the cash that's flowing through the industry. That way, if a regulating agency should ever approach the business, they have the paperwork to back their claims.

"If you don't pay taxes, you go to jail, and your business is taken away," Peterson said. "If you don't pay employees or hire them properly, you lose your business as well. There's a high risk of not doing things by law, so we alleviate that."

Adam C. Uzialko

Adam received his Bachelor's degree in Political Science and Journalism & Media Studies at Rutgers University. He worked for a local newspaper and freelanced for several publications after graduating college. He can be reached by email, or follow him on Twitter.